|Shares Out. (in M):||1||P/E||12.8x||9.1x|
|Market Cap (in $M):||8||P/FCF||8.0x||7.1x|
|Net Debt (in $M):||0||EBIT||1||2|
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If you are interested, as we always are, in investing in dominant (monopolistic in this instance) businesses at bargain valuations and are less concerned about liquidity, then Paradise, Inc. (PARF) could be an outstanding addition to your portfolio. The critical attribute that makes PARF such a great business is its monopolistic market position. Let me quote from the Company's recent annual report, "While there is no industry-wide data available, management estimates that the Company sold approximately 80% of all candied fruits and peels consumed in the U.S. during 2009." Candied fruits and peels? Yes, the Company is the dominant manufacturer in North America of glace' or candied fruits which are mostly used to make that Thanksgiving and Christmas staple, the fruitcake! In addition, the shares trade for less than one half of book value, two thirds of net current assets and at about eight times expected free cash flow! We consider these shares to be extremely undervalued, to put it mildly.
PARF traces its origins to a subsidiary of a diversified corporation started shortly after WW II, but shortly thereafter, Candied Fruit became the focus of its business and the other operations were either sold or closed. In 1961 current management purchased the Company and the name Paradise Fruit Company was adopted and later incorporated in 1965 as Paradise Fruit Company, Inc. Through ever increasing diversification and a number of acquisitions of related entities, the Company's name was changed in 1993 to Paradise, Inc. Current management holds a 42% stake in the Company. An unrelated party, Salvatore Muoio, holds a 7.4% position in the shares. Unfortunately, the shares tend to be very illiquid and trade infrequently.
The Company operates in three related business segments: glace' fruit, injection molding and on an opportunistic basis in the fresh/frozen strawberry market.
PARF's main business segment, glace' fruit, a prime ingredient of fruitcakes and other holiday confections, represented 70% of total net sales during 2009. These products are sold to manufacturing bakers, institutional users, supermarkets and other retailers throughout the country. Consumer demand for glace' fruit product is highly seasonal and traditionally strongest during the Thanksgiving and Christmas season. In fact, almost 80% of glace' fruit product sales are booked during the eight to ten weeks period beginning in mid-September. Since the majority of the Company's customers require delivery of glace' candied fruit products during this relatively short period of time, PARF must operate at consistent production levels from as early as January through the middle of November of each year in order to meet the peak demand. Thus, this requires the Company to make significant short-term borrowings during the year to fund working capital requirements to cover the cost of raw materials, factory overhead and labor expense needed to produce inventory. This combination of building and financing inventories during the year, without the opportunity to record any significant fruit product revenue, results in the generation of operating losses well into the third quarter of each year. Therefore, quarterly results tend to be of limited value for gauging the company's full-year performance. In addition, comparison of current quarterly results to the previous year's corresponding quarter produces an incomplete picture on the Company's performance due to year-to-year changes in production schedules, seasonal harvests and availability of raw materials, and in the timing of customer orders and shipments.
During the first several months of the year, the Company contracts with its commercial baker customers for future delivery of quantities representing a substantial portion of the sales of fruit cake materials to institutional users. Deliveries against these contracts are completed prior to the end of the calendar year. Many of the commercial bakers and other institutional accounts face the same seasonal demands as the Company, and must contend with similar short-term working capital requirements. The Company accommodates some of these customers with extended payment terms of up to ninety days. By the same token, many suppliers offer similar extended payment terms to the Company. It is a trade practice to allow some supermarket chains to return unopened cases of candied fruit products that remain unsold at year-end, an option for which they normally pay a premium. A provision for the estimated losses on retail returns is included in the Company's financial statements, for the year during which the sales are made. With the continuing acquisitions, mergers and other consolidations in the supermarket industry, there is increasing concentration of candied fruit buying activity. During 2009, the Company derived approximately 17% of its consolidated net sales from Wal-Mart Stores, Inc. through an exclusive use of a Paradise-owned and controlled brand. In most circumstances, this significant sales volume would provide Wal-Mart with a strong position to dictate pricing and terms to the Company. This situation is obviously quite different. Given PARF's dominant (monopolistic) market position, Wall-Mart does not have a viable alternative supplier for its candied fruit requirements which obviously significantly limits its ability to dominate the relationship. In fact, one might argue that, for once, Wal-Mart is the inferior party in the relationship!
Paradise's other significant business segment, Paradise Plastics, Inc., (30% of 2009 sales) a wholly owned subsidiary of Paradise, Inc., produces custom molding products, which are not subject to the seasonality of the glace' fruit business. This segment includes all injection molding and thermoforming operations, including the packaging for the Company's fruit products. Only sales to unaffiliated customers are reported. In the plastics molding segment, sales to unaffiliated customers continue to strengthen. This trend began several years ago when management shifted its focus from the sale of high volume, low profit "generics" to higher technology value added custom applications. Some molded plastics container demand is seasonal since a substantial portion of sales are made to packers of food items and horticultural interests, with seasonal growing and/or harvest seasons, but this does not materially impact the company's working capital needs.
During 1993 the Company launched an enterprise for the growing and selling of strawberries, both fresh and frozen. Plant City, Florida, the location of the Company's operations, considers itself the "The Winter Strawberry Capital" because of the relatively large volume of fruit that is grown and harvested locally, mostly from December through April of each year. However, once competing fresh berries from the West Coast of the USA begin finding their way to market, the price of Florida fruit begins to decrease, and local growers find it difficult to compete. While there are significant freight cost advantages in the sale and marketing of local strawberries to customers in the eastern U.S., growers and producers on the West Coast still dominate pricing and marketing conditions. Therefore, PARF is very opportunistic and limits its participation in this market to years in which basic supply and demand statistics, such as West Coast harvest predictions and frozen strawberry prior year inventory carryovers, lead to a reasonable expectation of profitability.
Here is a summary of the Company's recent performance: ($ in Millions)
2010 (9 Mo.) 2009 2008 2007
Sales $13.1 $23.2 $25.6 $25.5
Net Income 0.40 0.47 0.65 0.88
EPS 0.78 0.79 1.45 1.61
Flow/Share 1.57 1.95 2.38 2.76
We provided 2010 year-to-date results for informational purposes, but, as we noted above, due to the seasonality in the fruit segment they are of limited value in assessing the Company's 2010 performance, but we do expect improved results in 2010 relative to 2009. Paradise Plastics, which is not subject to seasonal fluctuations, generated a 12.0% increase in net sales to unaffiliated customers for the first nine months of 2010 compared to the similar reporting period of 2009. Plastics sales have continued to rebound steadily from 2009. This growth which includes increased sales from customers within the housing market has also been supported by additional sales related to the health care, food processing and aerospace industries
Let's consider the more representative 2009 full-year results. Fruit segment net sales in 2009 were $16.3 million compared to $17.5 million for 2008 resulting in a 6.9% decrease in net sales. With the downturn in economic activity beginning in the fourth quarter of 2008 and continuing through the entire year of 2009, PARF's glace' fruit customers remained conservative in ordering during the summer and fall for the 2009 holiday selling season. Paradise Plastics net sales were $6.9 million for 2009 compared to $8.1 for the similar reporting period of 2008. The decrease in net sales to unaffiliated customers was 15.4%. This decrease was primarily caused by the downturn in the housing industry as existing customers directly related to the home building and home improvement market reduced their custom plastics molding orders. Furthermore, Paradise Plastics customers in other industries also reduced their level of orders as due to economic conditions. In May 2009, as a result of the decrease in net sales activity for the fruit and plastics segments the Company took action to cut costs. Executive salaries were reduced 15%, salary employee weekly compensation was reduced 10% and merit increases awarded in January 2009 were rescinded. In addition, management terminated and or eliminated 15 full-time positions. As a result of these actions along with limiting levels of overtime by all existing employees the Company reduced total payroll and related taxes in excess of $550,000.
The Company's balance sheet is (and has remained) extremely conservative and essentially bullet-proof. As of 9/30/10, the company had a tangible book value of $32.43 per share, net current assets of $23.91 per share, a current ratio of 3.1, no long term debt and short term borrowings to fund inventory of only $4.3 million, which will be reduced to close to zero by year-end as the inventory is sold-off and a cash balance of probably in excess of $6 per share is generated.
How do we value these shares? We can take several standard valuation approaches without considering the company's dominant market position. We should expect recovering 2010 earnings to be about $1.25 per share and to approach $1.75 per share in 2011 as the economy continues to recover. Free cash flow should exceed $2 per share in 2010 and $2.25 per share in 2011. So if we value the shares at ten times this year's free cash flow we would get a valuation of about $22.50 per share. This cash flow valuation fails to consider the highly unlevered balance sheet which features net current assets of about $24 per share. Thus, we have a company that could be liquidated, giving zero value to its franchise, significant land holdings and plant assets, for $24 per share! Obviously, these two valuations require some additional premium from the company's dominant market position and inherent future growth. We leave it to you to determine the Company's fair value. We are not ones to assign pin-point precision to company valuations and recognize this process to be controversial and to have significant artistic components. In this situation we believe it suffices to state that under any reasonable valuation methodology PARF is worth materially more than its current $16 share price.
2) Possible dividend increase (The Company currently pays an immaterial $.05 annual dividend.)
3) Sale of the Company/Management's need for liquidity. (CEO and Chairman is 76 years old.)
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